Wharton’s Daniel Raff and former Hasbro executive Marc Rosenberg discuss the bankruptcy filing by Toys ‘R’ Us
It has been an emotional week for Americans who were once, as the commercials would say, “Toys ‘R’ Us kids.” The Wayne, N.J.-based toymaker filed for Chapter 11 bankruptcy protection on Monday in order to restructure some $5 billion in debt. Toys “R” Us has been battered in recent years by stiff competition from Amazon, Walmart and Target, but the overhang of a $6.6 billion leveraged buyout in 2005 made its financial troubles worse; more than $5.3 billion of that was financed by debt.
Even so, the bankruptcy protection could provide Toys “R” Us with ways to stabilize its finances, said Wharton management professor Daniel Raff. It could also give the retailer the leverage to employ creative strategies to increase customer traffic at its network of 1,600 stores across 38 countries, said Marc Rosenberg, former executive vice president of marketing for Hasbro-Tiger Electronics , who is now an entrepreneur focused on the millennial generation.
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Raff and Rosenberg discussed where Toys “R” Us went wrong and how it can reorganize on the [email protected] show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)
Following are select takeaways from their commentary.
The Amazon Factor
Once upon a time, Toys “R” Us was the category killer. The chain traces its origins to Children’s Bargain Town, a store that founder Charles Lazarus opened below his father’s bicycle shop in Washington, D.C., in 1948. Several decades and a few name changes later, Toys “R” Us had fashioned itself as a supermarket for toys, becoming the dominant force in the industry in the 1980s and early 1990s. Mom and pop toy stores found it hard to compete, and the chain’s ubiquitous “I don’t wanna grow up, I’m a Toys ‘R’ Us kid …” commercial jingle became a lifelong earworm for millennials and Gen Xers.
Toys “R” Us has been incurring losses since 2013, although it has been narrowing them in recent years; in fiscal 2016, it posted a $36 million net loss on revenues of $11.5 million. It joins about three dozen other retailers that have filed for bankruptcy since the beginning of the year, resulting in widespread job losses and store closings. Although bricks and mortar retailers are facing increasing competition from online rivals, that’s not the only reason for Toys “R” Us’s problems. “The first thought that comes to people’s minds is that this is all about Amazon and the fate of big-box retailing,” said Raff. However, he noted that “the central line of this story is actually much more to do with leveraged buyouts and loading debt onto operating companies.”
Rosenberg agreed with Raff and noted that unless a particular toy was exclusive to the retailer, Toys “R” Us hasn’t been giving shoppers enough of an incentive to pay the chain a visit. Most popular toys can be found at “everything” stores like Target and Walmart that are a regular part of consumers’ routines, saving them the extra trip to a specialty retailer like Toys “R” Us; Walmart alone has about 120 million people visiting its stores each week, or about a third of the U.S. population, he added.
Was It a ‘Real Estate Play’?
Was the filing for bankruptcy protection by Toys “R” Us inevitable? Rosenberg said he’d been hearing of the possibility literally for years, ever since the company went private in July 2005 with a $6.6 billion leveraged buyout by a consortium of investors led by Bain Capital Partners; Kohlberg Kravis Roberts; and Vornado Realty Trust. He noted that some observers have characterized the bankruptcy filing as simply a strategic tactic to refinance the retailer’s debt. “It had been talked about for so long that at some point it had to happen,” he added.
The company has debt payments due in 2018 and 2019 that it would have found difficult to manage without bankruptcy protection. “To have to make a $2.9 billion debt payment and keep operating the way it was is unfathomable,” Rosenberg said. According to a Bloomberg report, “For years the company had been rolling over its debt, often secured against the value of its land.”
Raff suggested that an exit plan for investors may have been in the cards. “The structure of funds that put up the money for buyouts generally does not envisage holding properties they buy for anything like the period of time that they have held Toys ‘R’ Us,” said Raff. “The proper interpretation of that is that either the company was not what they thought it was, or the circumstances have changed, and their expectations about how the company could function as a revenue- and profit-generating machine were just off.”
Rosenberg agreed that timing was likely a factor in the move. “A lot of it seemed to have been a real estate play,” he said. Toys “R” Us has 1,600 stores in its network, of which it owns about 300 stores.
Gaining Value from Physical Stores
Toys “R” Us is in a tough position as consumer habits shift toward e-commerce. “Toys are particularly suitable for online shopping,” wrote The Economist in its edition this week. “Unlike a dress, they do not need to be tried on for size, and unlike a peach they do not need to be felt for ripeness.”
But even as online channels offer stiff competition, the physical Toys “R” Us stores could be “competitively valuable” if the retailer created a strong visitor experience around them, according to Raff. “Being able to offer [toys] in a bricks-and-mortar setting with an excellent selection you can actually look at, [where] you can have your kids there and be confident that you are not getting something they are not going to like, and where there’s a staff that can help you figure out strategies and selections, and so forth [is an asset.] It’s not as if the real estate is systematically in the wrong place.” However, he also noted that the new owners of Toys “R” Us “haven’t invested in or been nearly as effective in investing in online capabilities.”
With a seamless online and offline experience, Toys “R” Us could use its physical stores as a place where consumers can see, touch and try out toys, and then be funneled to a website to actually buy them. “People would — sometimes even standing in the store — buy [their toys] online,” Rosenberg said.
Pathways to Recovery
Toys “R” Us continues to have a future, and notwithstanding what critics might say, kids have not abandoned toys completely in favor of smartphones or tablets, said Rosenberg. The “right strategy” for Toys “R” Us is to find ways to bring people back into its stores with events like birthday parties, tournaments and games, and in partnership with its vendor network.
Raff said the reorganization allows Toys “R” Us to get out of an element of its cost structure that was constraining the company’s ability to make the right strategic moves. It buys the company time to rearrange its finances, and it could renegotiate cash obligations that are impeding its ability to run a viable business, he added.
A day after the filing, Toys “R” Us secured court approval to access interim financing of $2.2 billion that the company could use during the restructuring to pay wages and benefits, honor customer programs and pay vendors. Dave Brandon, chairman and CEO of Toys “R” Us, said in a statement that he hopes the restructuring will enable the company “to be a strong champion of play for all kids and a trusted friend to parents everywhere.”
Meanwhile, the company isn’t letting the bankruptcy sour its cheer for the coming holiday season; it still plans to hire thousands of temporary workers to keep up with demand. And last month, after a two-year absence, it also reopened with much fanfare its experience-heavy Times Square store, just for the holidays.
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